The Deposit Franchise and the Risk-Taking Channel of Monetary Policy

Abstract

We develop a tractable model in which a bank’s deposit franchise shapes its risk-taking response to monetary policy. Banks with weaker pass-through to deposit rates (lower deposit betas) see larger profit gains when rates rise and therefore reduce risk-taking more after contractionary shocks. We test this channel using the Federal Reserve’s confidential loan-level data, interacting high-frequency monetary policy surprises with pre-determined banks’ deposit betas, in regressions saturated with bank and borrower-time fixed effects. We find that low-deposit-beta banks reduce risk-taking significantly more following monetary tightening, confirming that the deposit franchise plays a crucial role in the interaction of monetary policy and financial stability. In a horse race against bank capital-based explanations of risk-taking (e.g., search-for-yield), our deposit-franchise mechanism retains independent explanatory power.